I personally don't think legislation is the answer but I think banks rely too much on credit scores and not enough on other factors when making loans. It is a good tool but not the entire solution.

Sliding economy raises questions about credit scoresBy Kathy Chu, USA TODAYThrough all the foreclosures, staggering stock market losses and dissolved personal fortunes, one measure of Americans' financial health has remained surprisingly steady during the recession: the consumer credit score, used by banks and lenders to determine how much credit to give borrowers, and at what rates.

But that's finally beginning to change, and the economic turmoil in households is not solely responsible.

Banks and lenders are shoring up risks — closing a record number of credit card accounts and reducing millions of dollars in credit lines. As they clamp down, even some consumers with excellent credit and spotless payment records are seeing their credit scores reduced because of the diminished credit lines. That, in turn, can hamper consumers' ability to get credit elsewhere.

Mary Lou Reid, 61, says two of her credit cards were closed recently because of inactivity, eliminating $47,000 of available credit. Her credit score dropped to 726 from 757. The most widely used credit scores run from 300 (very poor) to 850 (pristine).

"They didn't give me any warning," says Reid, of Arcadia, Calif. "One needs to feel in control of one's life, and what they've done here is cut me out of the equation."

As lenders' appetite for risk wanes, they're pulling back on an unprecedented amount of credit — up to $2 trillion on cards alone by 2010, estimates analyst Meredith Whitney.

"It becomes this self-fulfilling problem," says Mark Zandi, chief economist at Moody's Economy.com. "Lenders cut credit lines, and if consumers simply do what they had been doing, their credit score could fall. Other lenders respond by cutting their own lines or raising rates."

The cycle concerns consumer advocates and some legislators. Some wonder whether restrictions should be imposed on lenders' ability to slash credit limits and close accounts. And if scores can drop even if consumers do nothing wrong, they say, it raises the question of whether there's a flaw in the credit scoring formulas relied upon by the nation's lenders, insurers, and increasingly employers and landlords.

USA TODAY, in previous stories in its "Credit Trap" series, has reported that during the housing boom, banks sharply raised card limits in part because of a surge in home equity, then guided borrowers to use mortgages to pay off card balances.

Now, when it's already difficult to qualify for loans, lenders' actions can lead to deteriorating credit scores that can put much-needed credit out of reach for a growing number of consumers. Those who get loans may have to pay higher interest rates. Lenders also may seize upon lower credit scores to increase interest rates, pushing consumers deeper into distress.

Jobs, and even auto insurance, can be affected if consumers don't have good credit ratings. Most auto insurers now take credit scores into account in determining their rates. And 42% of U.S. employers routinely do credit checks on job applicants, according to the Society for Human Resource Management.

Bank officials say they're aware of growing concerns about the effects credit-line reductions and account closures are having on credit scores. But as the economy worsens, they say, more consumers are struggling, so it's only natural that institutions take steps to reduce risk before borrowers default.

Bank officials also say they have no control over credit score calculations — and, like consumers, they don't know exactly how such scores are determined.

"It's tough to connect any one action (by the lender) to consumers' credit score," says Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, which represents large banks.

Even so, banks are concerned enough about the issue that they've asked Fair Isaac, the creator of the widely used FICO score, to study whether — and to what extent — their tightening of credit affects scores. Fair Isaac plans to complete its preliminary study in the next few weeks.

The cycle of one bank's actions potentially affecting a consumer's credit score and leading to other banks taking similar steps is troubling, says Sen. Chris Dodd, D-Conn. "Banks can only stay in business if they've got creditworthy customers. If you're destroying people's credit ratings ... then you've got a customer base that can't afford your products."

The problem, he says, should provide impetus for "future examination of how credit scores are determined."

Tom Quinn, vice president of scoring at Fair Isaac, says he believes credit scores remain effective in predicting the likelihood consumers will repay their bills.

"The challenge is that we haven't had a recession like this since the Great Depression, and we didn't have credit scores back then," he says. "We haven't really had an opportunity to see" what will happen with credit scores in such an environment.

Seth J. Chandler, a law professor at the University of Houston, says although credit scores are "incredibly powerful, lenders might start to revise the importance they put on (them) if they no longer reflect reality."

A 'downward spiral'

Reid says she's always paid her credit card bills on time and worked hard to get her credit score to the mid-700s. Having two accounts closed will erase decades of good credit history on the cards, she says. And because she's near retirement, "I don't have another 37 years to repair this problem."

Talbott says that only a minority of borrowers will get their card limits reduced. For those who do, it's "unfortunate" if scores drop, he says.

"This is sort of the downward spiral of the worsening economy," he says, "that leads to increased risk, the closing of credit lines, a lower FICO score and increased cost of credit when people can't afford it."

It's understandable, says John Ulzheimer, a former executive at Fair Isaac and Equifax credit bureau, that lenders want to reduce risk in this economy. "Having said that, you can't simply ignore the reaction of your actions," says Ulzheimer, now the president of consumer education at Credit.com. "That would be irresponsible for a large lender."

Credit scores caught on in the 1960s as a uniform way to measure consumers' likelihood of repaying their bills — and thus, their potential profitability to lenders. Before then, merchants shared information about consumers to decide whether to extend credit.

Today, 90 of the largest 100 financial institutions rely on FICO scores, according to Fair Isaac. Credit bureaus also sell proprietary credit scores, and team up to put out the VantageScore, a competitor to FICO.

Scores are starting to fall in the parts of the country most affected by rising home foreclosures and credit card debt, according to analyses of credit bureau data for USA TODAY by Experian credit bureau, and separately, Moody's Economy.com and Equifax.

But in the Riverside, Calif., metro area, median credit scores dropped 17 points during that time. Credit scores in and around Phoenix dropped about 14 points, and they fell 12 points in the Miami region.

Yet scores lag the economy, because it may take awhile for consumers' financial situations to decline, says Michele Raneri, senior director of analytics for Experian.

It's likely that scores have a ways to fall. "Given surging unemployment, I'd be surprised if we don't see a measurable erosion in credit scores," says Zandi. "I think it's happening right now."

Because credit cards are more common than mortgages — 51.4 million households have first mortgages, while nearly all the nation's 114 million households have at least one card — card-related actions can hurt overall scores more than mortgages.

"There are a lot more card holders than mortgage holders," Zandi says. "It's credit cards that are really going to cause people problems on their credit scores."

Fair Isaac and the credit bureaus don't disclose exactly how credit scores are calculated. But a key factor in the score is what the industry calls "open to buy," basically how much of a consumer's credit line is drawn down on plastic. Also called the credit utilization ratio, this — along with a handful of other variables — makes up a combined 30% of your FICO score, Fair Isaac says. Other important components include overall payment history, how long a consumer has had credit, and the types of credit.

When lenders close accounts or slash credit limits, it often boosts the percentage of available credit consumers are using. That's the key reason scores could fall.

Mike Century, 48, of Bloomington, Ill., says Bank of America closed one of his card accounts because of inactivity and reduced limits on three other cards, eliminating about $20,000 in available credit. That caused his scores to drop 17-44 points, he says. Even though he still has enviable scores — the lowest is now 710 — he worries he no longer qualifies for the best rates on loans.

Some lenders have tightened their underwriting criteria and now require a FICO score of 750 to qualify for the lowest rates.

Lenders' "actions make you appear riskier than you are," Century says. Bank of America declined to comment on Century's case, citing privacy concerns. However, Betty Riess, a spokeswoman, says the bank is "taking a more aggressive look at accounts to control risk, given the current environment."

As part of this review, the bank may close accounts inactive for a year and also adjust credit lines, Riess says, "based on (consumers') risk profile and their performance with us."

As more banks pull back on credit, it's straining their relationships with longtime customers.

Russ Reed, 46, says he and his wife, Darlene Guinto, 38, no longer want to use their American Express card after the bank slashed the limit more than 80% to $4,600. The bank, in a letter, cited a history of late payments. Reed says they paid late only twice over several years, and never on American Express bills.

Reed later was denied a Wells Fargo business loan. It's likely his $35,000 in low-rate credit card debt — from starting an environmental engineering firm — was a factor. But Reed says the bank cited his available credit.

American Express spokeswoman Molly Faust says that while the bank does monitor credit bureau information, it mostly looks at borrowers' debt compared with their financial resources in deciding whether to cut credit lines.

Banks warn against limits

The Federal Reserve has approved a new policy — which takes effect in 2010 — that restricts lenders' ability to raise credit card rates and impose fees. But it doesn't address lenders' ability to change credit card limits and close accounts.

Consumers Union, the publisher of Consumer Reports, is lobbying for legislation designed to ensure that lenders conduct "sound underwriting" when they extend credit, so they don't have to slash credit lines and close accounts when the economy slumps — dragging down credit scores.

Lenders also should be banned from raising interest rates or taking other adverse actions against consumers if their credit scores dropped solely because they had their credit lines reduced or accounts closed, says Lauren Zeichner Bowne, a staff attorney at Consumers Union.

This ripple effect is "absolutely happening," saddling consumers with higher fees and rates, and more closed accounts, says Ken Lin, who developed credit models for banks before becoming chief executive of CreditKarma.com, a consumer website.

Banks warn that imposing restrictions on their business practices could raise costs for everyone and reduce credit further for those who need it.

"The need to adjust for changing risk is the only way (banks) can make revolving credit available," says Ken Clayton, a senior vice president at the American Bankers Association.

Charleen Lee, 62, of Albany, Ore., says she's taken her complaints about banks' actions to state legislators.

Lee says Chase closed a card with a $15,000 limit in December, citing "inactivity" and the potential for fraud. Angered, she closed another Chase account because she no longer wanted to do business with the company.

What Truly “Wealthy” People Know about MoneyIn the deepest sense money isn’t real. It’s true. Intrinsically it has no real value. It’s just a fancy piece of paper. If you were to take our money to an alien world what could you use it for? Money is simply a mutually agreed upon token we use to exchange for things that provide REAL VALUE to us like food, community, comfort and shelter. It is the thing we buy with money or the thing people buy from us that has actual value.

Why then do we stress over money? You stress about money because you have mistakenly identified money, the actual money, as the thing of value. You feel stress because you are “fighting” to get something that doesn’t exist- the closer you get the more elusive it becomes. There is another way.

Look at the thing of value as what’s underneath the money. If you want to generate more income, then think of how you can generate more value, not more money. Also recognize that both value and wealth come in more forms than just money. You can be financially wealthy but be bankrupt in true friendships, peer respect or health.

This observation is universal; applicable to anyone, anywhere in any business or organization. It applies to the artist business, the management company and the United States Government.

Think about this on a higher plane. We are all connected in a giant ecosystem and the flow of money is merely a manifestation of the exchange of our energy. Next time you are stressed out about money be self-reflective. Rather than stressing about how you can get more money for money’s sake, focus instead on how you can provide more value to more people. All sorts of wealth will flow from this mindset.

Starting Feb. 22, when major provisions of the Credit CARD Act of 2009 take effect, anytime you apply for a new credit card or your credit limit is increased on an existing account, card issuers must consider whether you can actually repay the card loan. In many cases, that will mean a behind-the-scenes financial checkup on a credit card applicant's income or assets.

But you're unlikely to be asked to hand over paycheck stubs or other financial documents to issuers. Instead, you'll be judged by new statistical tools -- called income estimation models -- rolled out recently by the major credit reporting bureaus and approved by the Federal Reserve for use in assessing ability to pay. The tools will estimate a consumer's income based on card application information, credit bureau data and information from employment and IRS tax databases.

Retailers relievedMajor retail stores had complained to the Fed that its ability-to-pay rules, as initially proposed, could kill instant in-store credit offers pitched to shoppers at the cash register. The proposed rules had required card issuers to collect financial information from applicants, but final credit card reform law guidelines issued Jan. 12 by the Fed allows issuers to use statistical income estimation models developed by the credit reporting bureaus.

As a result, "there is a partial sigh of relief" from retailers, says Mallory Duncan, senior vice president of the National Retail Federation. "Using that kind of estimator will cost more money, but it's preferable to asking people for income information at point of sale."

Macy's, Best Buy, Lord & Taylor and Saks Fifth Avenue said they feared customers would be reluctant to hand over sensitive private financial information to store clerks in checkout lines (called point of sale). The proposed requirement, they said, would impede sales of consumer goods at a time when the country was struggling to rebound from a recession.

"The new rule is you are required to collect it, but in lieu of that you can use an estimation model," Duncan says. He said stores will likely use the behind-the-scenes income estimation tools and avoid asking shoppers for paycheck stubs or salary information -- a process that would have been rife with logistical hurdles.

He adds: "They're probably not going to give those estimates out for free. That will probably drive up the cost of those decisions at point of sale."

With only about five weeks until the rule takes effect, retailers will be scrambling to put the new income screening procedures in place. "They have a very limited time in which to pull this together," Duncan notes.

Retailers had asked the Fed to consider waiving the ability-to-pay rule for accounts with relatively small credit limits. Regulators rejected that suggestion, however, noting that even low credit limit accounts "could still have a significant impact on a particular consumer, depending on the consumer's financial state. For example, subprime credit card accounts with relatively 'small' credit lines may still be difficult for certain consumers to afford. Suggesting that these card issuers may simply avoid consideration of a consumer's income or assets may be especially harmful for consumers in this market segment."

National Retail Federation Consumer groups had asked the Fed to consider placing more stringent income requirements on people under 21, such as requiring them to have lower debt-to-income ratios or only considering income from wages they earn. Regulators, however, declined to make it harder for young adults to show ability to pay, saying the rules established for all borrowers were sufficient for young people and avoided "unnecessarily impinging on their ability to obtain credit and build a credit history."

More financial scrutinyWhy the additional scrutiny for credit card applicants? The credit card reform law includes a provision requiring credit card issuers to take additional steps to prevent customers from getting in over their heads in credit card debt. The goal: preventing someone with no income or assets from getting a plastic license to spend that could lead to bankruptcy.

Under the final ability-to-pay rules, card issuers must create policies and procedures for reviewing ability to pay credit card debts that consider at least one of the following: the ratio of the consumer's debt obligations to income; the ratio of debt obligations to assets; or the income the consumer will have after paying debt obligations. The debt-to-income ratio is a common financial measure used to determine financial stability of an individual or company. It is the amount of debt owed as a percentage of the amount of income available to repay it. The lower the ratio, the better.

Regulators said card issuers may consider, among other things:

Salary, wages, bonus pay, tips and commissions from full- or part-time, seasonal, military or irregular jobs and self-employment.Interest, dividends, retirement benefits, public assistance, alimony checks, child support and other kinds of maintenance payments.Savings accounts or investments.Credit reports and credit scores.No verification requiredThe Fed said card issuers will not be required to verify income amounts reported by consumers -- a provision sought by consumer groups as an additional safeguard against people overstating their incomes to get higher credit limits.

"For an ability-to-pay provision to have real bite, issuers need to require some sort of verification as they do for other sorts of loans," says Lauren Bowne, a staff attorney at San Francisco-based Consumers Union, the nonprofit owner of Consumer Reports magazine. "They could have added a bit of teeth to it."

Both consumer groups and bankers noted that the income estimation models are new -- Experian launched its service in November and Equifax started offering its products in December. Many have questions about how the models will work and their accuracy in predicting income levels. If they base their estimates on credit bureau and employment data, how would they handle people who have limited credit histories and who recently changed jobs, received raises or lost their incomes? Would the income models be able to accurately estimate incomes for these situations?

The credit bureaus acknowledge that the models are not perfect.

"Income estimation models are built to handle the majority of individuals, and there will always be some special cases where income estimates are less accurate," says Brannan Johnston, Experian's vice president of income and deposits. Experian's tool, called Income Insight, uses the credit bureau's payment database and verified income databases.

"Only changes reflected on a consumer's credit report will affect the estimate," Johnston says. The fact that someone has been laid off typically shows up in the credit report as missed payments and higher debt utilization ratios. Similarly, a person getting a new job often has improved credit profiles.

"As long as a person's credit report changes, the estimate provided by Income Insight will change as well," Johnston adds.

How income estimation models workHow will credit card applications be handled? Most credit card applications currently ask for household income information. It is self reported by the consumer and usually not verified, meaning the bank doesn't ask you to provide copies of paycheck stubs, investment account statements or income tax returns as it would if you were applying for a mortgage loan.

When applicants enter their annual incomes, that information -- along with their present and former addresses, birthdays and Social Security numbers -- will be forwarded to a credit bureau. Within minutes, the bureau's database of payment histories can generate a credit score that rates the applicant's creditworthiness. In the same amount of time, the bureau's new income estimation model can generate an estimated income to the nearest $1,000.

Johnston from Experian says no lenders are allowed to reject credit card applicants based solely on the income estimation tool.

If the model spits out an income amount that is dramatically different from what the consumer has reported, it triggers an alert. The creditor will ask the consumer to submit additional information. That may include copies of recent paycheck stubs, tax forms or other financial paperwork.

"More than 85 percent of the consumers where we estimated income of less than $35,000 actually had incomes of less than $50,000," Johnston says of the model. "It will rarely be dead on. No borrower will be turned down for credit based on that."

Similarly, if a consumer has a "thin file," meaning he or she doesn't have a significant credit history or work history, that will signal the need for additional verification by the card issuer.

Nessa Feddis, senior counsel for the American Bankers Association trade group, says some banks may still grant credit cards to those thin file applicants. "They may start people out with a very low credit limits," she says. "And then, with experience, see how they do and then adjust appropriately."

Income doesn't tell the whole storyBanks and retailers argued that knowing how much a cardholder earns does not help lenders determine whether they will repay their credit card bills. Past payment history -- as shown in credit reports and in credit scores -- is a better indicator of ability to pay. Feddis, from the bankers association, makes a distinction between ability to pay and willingness to pay debts. Cardholders can have large incomes showing ability to repay, but not be willing to pay their credit card debts before they pay other financial obligations.

"Credit scores show more willingness to repay," Feddis says. "If you're willing to repay, generally you're going to be able to pay."

"It's not always obvious who is going to repay a loan," Feddis says, adding "You can't predict with 100 percent accuracy who is going to repay their loans, otherwise you would only give loans to people who don't need credit."

The economy also plays a role in who can and can't pay their credit card bills. "Nobody knows who is going to lose their jobs," Feddis says. "It was only when unemployment started to get into the double digits that you saw people not paying on their credit cards. The credit card companies, prior to the unemployment rate increases, were doing fairly well."

Adds Bowne from the consumer group: "It will be interesting to see what changes are coming: Are there going to be more hoops to jump through just to apply for a credit card?"

If you're trying to decide whether to rent a home or buy one, here's a useful back-of-the-envelope calculation:

1. Take the price of a home you'd be likely to buy.

2. Divide the price by 20.

3. Compare the result to the annual rent on a comparable home.

If the result is higher than the annual rent, renting is probably a better deal.

A quick example: Take a $500,000 home. If you divide the price by 20, you get $25,000. So if the annual rent is less than $25,000 -- that's a monthly rent of roughly $2,100 -- there's a good chance you're better off renting.

As a story in this morning's NYT notes, the ratio was higher than 20 in much of the country during the past decade -- during the bubble, the price of buying rose a lot faster than the price of renting.

But now, the ratio has fallen below 20 in many places, suggesting that buying is now often a better deal. (Here's a useful graph of how the cost of renting-versus-owning has changed.)

Of course, the rent ratio is just one factor, and there are (obviously) all kinds of variables to consider -- how long you're going to stay in a place, what's going to happen in the real estate market, and all the intangibles associated with both renting and owning. Still, I'm a sucker for a rule of thumb.

There is a percentage of your mortgage payment you add to the mortgage for Upkeep, I forget what that is, but I think it was a double digit. a double digit percentage for most wage earners is 100 or 200 dollars. That can make a big difference in what you can afford...........

That is why low mainenance was a selling point, with people being shoehorned into a house they could not afford in the first place..........

The other thing to consider is: Are you willing to spend at least 1 day a month doing house chores? Do you know how to change washers in the faucet, are you willing to get excesise pulling weeds, pushing a mower? Do you understand what to do to retack/stretch the carpet? Ther are things you should know and be able to do around a house before you own one. Just like there are things you should know about a car, a gun, a sword, a computer etc. before you should own them.

Mine is slightly different but I like that rule of thumb Rachel posted as an indicator of when homes are over-priced. I don't know when we all accepted the idea that it okay to do something (pay too much) just because everyone else is doing it.

A flaw in the analysis (IMO)is the idea that it is the same house you would rent or buy in the same area. My advice to some who can't afford it all in this time of low prices is to rent a small apartment while you buy the lot you would build on or buy a home in a lower priced area for rental and at least see some of the appreciation and accumulation of equity there that the homeowner would tend to see.

One remaining loophole in tax law is that you can still buy, live and fix up a house for 2 years and pay no gains tax on certain amounts of profit that you could then roll into the house you truly wanted. If you rent your dream home now, you might find yourself in a tougher situation to buy it later.

I have never used BILLSHRINK.COM but I really love Mint and Smartypig.

Web Sites that Help You Put Aside MoneyFree Online Tools Designed to Bring Out the Saver in You!

Play CBS VideoVIDEOWebsites That Help You Save MoneyHarry Smith spoke with Rebecca Jarvis about websites can help manage your money.

(iStockphoto)(CBS) With the economy recovering slowly, Americans are looking for quick and easy ways to save more money.

On "The Early Show" Tuesday, CBS News Business and Economics Correspondent Rebecca Jarvis pointed to several Web sites that specialize in helping you cut your monthly expenses and build your savings.

FOR REDUCING YOUR BILLS: BILLSHRINK.COM

This site gives you a way to compare prices on some of your biggest monthly expenses, and does all the hard work for you. With some simple information from you on your spending habits, the site can evaluate wireless cell phone plans, credit card offers, and cable/satellite TV packages in your local area to find out whether you're getting the best deal.

Here's how it works: -- Sign up for a free account -- If you're looking for a credit card, it will ask you questions about how much you charge on your credit card each month, how much you pay off, where you spend the most, and how you like to receive rewards. -- Then it will come back to you with a credit card offer that suits you best. It will even show you how much you will save based on the card you currently have. -- Same goes for wireless plans: Input information about your current plan, your usage, including how many minutes you use and texts you send; you can even tell the site which phone numbers you call most frequently. And it will come back with the best plan for you. -- They just launched a cable/satellite service search to determine if you're paying too much for TV. You input how much you currently pay, and the channels and features that are must-haves for your home. -- The site also monitors gas prices from stations in your local area to tell you where to get the best price. -- Best part: This all takes about five minutes of your time to compare wireless plans; credit card offers, TV/satellite packages and get an estimate on how much you could be saving. BillShrink will also monitor for changes in plans or new offers and alert you if a better deal comes along.

FOR BUILDING YOUR SAVINGS: SMARTYPIG.COM

This is essentially an online piggy bank that helps you save money for your short and long term goals.

Here's how it works: -- Sign up for free and establish a goal. For example, "I want to save $3,000 for that European vacation next year." Or. "I want to put away $600 for this year's Christmas shopping." -- Make an initial deposit of at least $25. -- Link your banking account to Smarty Pig (which is FDIC-insured) and it will automatically make monthly transfers based on how much you want to save and when you want to reach your goal. If you have extra money to contribute in as given month, you can do that, too. Even friends and family can contribute to your goals online. -- You can end a goal at any time. You can have the money deposited back into your checking account, take it on a debit card, or take it on a gift card. -- Best part: As long as your balance with SmartyPig is less than $50,000, SmartyPig offers 2.15 percent interest! That's more than four times the interest you receive at most brick-and-mortar banks right now. AND you can earn even more if you choose to redeem your goal money on a gift card from one of their selected retailers, including Macys, Gap, Home Depot, Best Buy, American Airlines, and Travelocity. (Also Amazon!)

FOR MANAGING YOUR MONEY: MINT.COM

For one stop shopping, MINT.COM has it all. For two years in a row, Mint has won the Webby Award for best Best Financial Services Web Site, and with good reason. Mint.com is essentially a place where you can sync up all of your accounts in one place and manage all your wealth -- your banking accounts, credit cards, 401K, home loans, investments - everything, to give you a complete picture of your finances.

How it works: -- Sign up for a free account and start selecting the institutions you have accounts with, ie; savings; mortgage, investments, etc.

-- Yes, you will need to give Mint your login and passwords for these accounts. DON'T WORRY. Mint.com is completely secured. It's a read-only site, meaning you cannot perform any transactions. If you do online banking, it's the same thing. -- People also love Mint for its budgeting capabilities. Mint will track all your spending, from rent to credit card purchases; and alert you if you're about to go over your budget in certain categories. It can even show you how your personal spending in certain categories compares to its other three million other users. -- Best Part: Mint has mobile apps for the iPhone and Droid. So, if you're out to dinner with friends, you can check your finances in real time and find out if you're about to bust your restaurants budget.